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Thursday, 5 May 2011

Price-level accounting

Price–level accounting

Entities generally choose to measure financial capital maintenance in nominal monetary units and thus apply the very erosive stable measuring unit assumption as part of the traditional HCA model. They generally value balance sheet constant items (e.g. equity) as well as most income statement items – which are all constant items – at Historical Cost. They value them in nominal monetary units as a result of the fact that they assume that changes in the purchasing power of the monetary unit are not sufficiently important to require financial capital maintenance in units of constant purchasing power during low inflation and deflation. Entities do not regard changes in the real value of money during low inflation and deflation as important enough for them to maintain the real value of capital constant with financial capital maintenance in units of constant purchasing power as they have been authorized in IFRS in the original Framework (1989) Par. 104 (a). Entities, in principle, assume there has never ever been inflation or deflation in the past, there is no inflation and deflation in the present and there never will be inflation and deflation in the future as far as the valuation of most constant items is concerned. They only value certain income statement constant real value non-monetary items, e.g. salaries, wages, rentals, etc in real value maintaining units of constant purchasing power and update them annually by means of the annual CPI during low inflation. They then pay these annually updated values monthly again implementing the stable measuring unit assumption.

Complete price–level accounting also called Constant Purchasing Power Accounting (CPPA) is an inflation accounting model whereby all non–monetary items – variable and constant items – are measured / valued in units of constant purchasing power by means of the daily US Dollar or other relatively stable foreign currency parallel rate or a daily index rate in order to maintain the real or non-monetary economy relatively stable during hyperinflation. IAS 29 does not require the valuation of all non-monetary items in units of constant purchasing power at the time of the transaction or event. IAS 29 and PricewaterhouseCoopers (amongst most others) accept the implementation of Historical Cost Accounting or Current Cost Accounting during the accounting period. IAS 29 requires the restatement of the HC or CC financial statements in terms of the period–end CPI in order to make them more useful during hyperinflation. The non–monetary or real economy of a hyperinflationary economy can only be maintained relatively stable by applying the daily parallel US Dollar exchange rate or a Brazilian–style daily index to the valuation of all non–monetary items instead of simply the restatement of HC or CC financial statement in terms of the period–end CPI as required by IAS 29.
The Framework is applicable


The implementation of the concepts of capital, the capital maintenance concepts and the profit/loss determination concepts during non–hyperinflationary periods are not covered in IAS, IFRS or Interpretations. These concepts are covered in the Conceptual Framework (2010), Par 4.57 to 110. There are no specific IAS or IFRS relating to these concepts. The Framework is thus applicable as per IAS8.11.

Deloitte states:

"In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the Framework. This elevation of the importance of the Framework was added in the 2003 revisions to IAS 8."

IAS8 Par. 11 states:

“In making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order: (a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and (b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.”

The valuation of the constant real value non–monetary items Issued Share capital, Retained Earnings, other items in Shareholders´ Equity and other constant items is thus covered in IFRS in the original Framework (1989), Pa. 104 (a).

Harvey Kapnick in the Sax Lecture in 1976 correctly predicted the course of the development of International Financial Reporting Standards:

“Confusion constantly arises between changes in value and changes in purchasing power. The fact is both are occurring and, while there may be an interrelationship, the effects of each should be accounted for separately. Thus, the debate concerning whether value accounting or price–level accounting should prevail is not on point, because in the long run both should prevail. The real changes in value should be segregated from changes resulting only from changes in price levels.”

Harvey Kapnick, Chairman, Arthur Andersen & Company, “Value Based Accounting – Evolution or Revolution”, Sax Lecture, 1976.

Nicolaas Smith

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